Wholesome Investing

Joseph Bornstein — Tue, 01 Jul 2008 09:31:06 -0400

July 1, 2008 - 09:00, Venture Capital Journal

Wholesome Investing

Story Link: http://www.vcjnews.com/story.asp?storycode=44803&newstype=A&pre=4#link3

Teaser:

The idea that you can do good for society and the environment-and still make a healthy profit-is starting to catch on

Even with a single bottom line-the raw pursuit of profit-first-time venture funds struggle to post positive returns. Add in a mandate to combine social good with financial gain, and odds of success would seem daunting enough to keep even the most risk-tolerant emerging manager from attempting a "double bottom line" approach.

Not so. This year, socially conscious venture funds are ramping up at an unprecedented scale. At least seven new and follow-on funds billed as mission-driven investment vehicles are on track to raise about $750 million this year (see table).

Nor are they reticent to spend. From organic school lunch servers to solar battery-charger developers to philanthropically minded online bookstores, social venture funds are bulking up their portfolios at a rapid pace. Few fund managers can brag of big exits. The vast majority, however, maintain that mission-focused funds can produce at least market rate returns-and possibly higher. LPs are increasingly signing on to the premise.

"It's really peaked in the last six months," says David Chen, founder of Equilibrium Capital, a planned $200 million fund focused on the cleantech and wellness sectors. Since he began raising the fund last fall, Chen has seen a marked increase in interest levels from investors of all stripes in the social venture asset class.

The rise in social venture comes as institutional and accredited investors are putting significantly more money into so-called socially responsible investment (SRI) vehicles. Today, roughly $2.71 trillion-or 11% of assets under professional management in the United States-are now involved in SRI, according to the Social Investment Forum, a trade group.

Private equity accounts for a miniscule portion of SRI investment. As of this year, an estimated $5.3 billion was under the management of 46 different socially or environmentally screened alternative investment vehicles, including venture, private equity and hedge funds.

But it's a rapidly growing universe. From 2005-2007, SRI assets increased more than 18%, according to the Social Investment Forum, which defines SRI as an investment process that considers social and environmental consequences of investments in its financial analysis.

The limited partners in socially responsible venture funds tend to fall into three camps, says J. Gregory Dees, a professor of social entrepreneurship at Duke University's Fuqua School of Business. There are wealthy individuals, banks and pension funds investing in community development, and foundations looking to incorporate a social mission. Foundations, in particular, are favored LP targets for newly launched funds.

"Social venture funds argue this is a way [for foundations] to kill two birds with one stone," says Dees. "Instead of making money so you can give money away, here you achieve your mission as you make money."

Evolving the Model
Considering that foundations comprise an outsize share of the limited partner universe, one might think do-gooder funds would be an easy sell. But history indicates otherwise.

"The early folks who were doing socially responsible investing often got the door closed in their face," says Dees. The professor once co-wrote a case study for Harvard Business School about the travails of Commons Capital, the social venture fund launched by angel investor Woody Tasch in 1989. Eventually, Tasch convinced the New York-based Jesse Smith Noyes Foundation to invest in the fund, but only after scores of others turned him down.

Another early entrant, the New Schools Venture Fund, didn't struggle so much to raise money. However, managers of the fund, which invests in non-profit and for-profit education ventures, did fret over questions of mission. Concerns on the for-profit side came to the fore, says Dees, after public school operator Edison Schools acquired Learn Now, one of the fund's portfolio companies. While the acquisition appeared at the time to provide a compelling financial return, Dees wrote in a case study, it was less clear whether it preserved the intended social impact of Learn Now as a quality education provider for students in low-income communities.

Other early efforts in socially motivated investing have involved angels. San Francisco-based angel fund Investors' Circle, launched in 1992, has invested more than $130 million to date in close to 200 companies and small funds addressing social and environmental issues. Other socially conscious angel networks include Seattle's Angels With Attitude and the Oregon Sustainability Angels Network.

In many ways, angel funds-typically backed by wealthy individuals who generally already pursue a social agenda in their philanthropic activities-seem to be an easier match for the mission-oriented investment model than venture capital. Venture, with its reliance on multiple limited partners and large institutional investors, makes for a more complex fit.

Of course, weighing an investment's appropriateness for fund LPs isn't a new practice. For decades, VCs have largely steered clear of deals involving sex and gambling, stayed away from rogue regimes and catered to regional LPs with mandates for local investment.

But social venture funds go beyond the longstanding industry practice of avoiding controversial investments. For these managers, the mandate isn't "let's not be evil," so much as "let's invest in what's good," says Josh Becker, co-founder of New Cycle Capital, a double-bottom line fund in Menlo Park, Calif.

The Deals
There's no universal sector focus or selection criteria for social venture funds, though certain types of businesses do account for a disproportionate share of investment. Food ventures are popular, as organic products fit nicely with social VCs views on sustainability. Funds have recently invested in such businesses as a sustainable seafood supplier, a purveyor of organic pizza crust, and Laloo's, a Petaluma, Calif. goat farm that makes premium goat's milk ice cream.

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